Timing is important in some categories of debt funds. So, why not use systematic investment plans (SIPs) to average out one's investment? Well, SIPs are not as good an idea for debt mutual funds as they are for equity funds because SIPs yield better returns than lump-sum investments only for those instruments which may see a dip during your investment period.
What SIPs do is that they allow you to postpone your investments so that you can average out your costs if the markets tank after your initial entry point. The tendency of equity markets to subject you to capital losses after you have invested is what make SIPs a great idea. But in the case of debt funds, you should remember that the NAV gains from two factors: the interest receipts from the bond/G-sec that will accrue steadily to the scheme throughout the year and the price gains on the bonds/G-secs due to market adjusting to interest-rate changes. Whether or not the capital gains on bonds come through, the interest accruals are bound to flow in, steadily increasing your debt-fund NAV. This is why debt funds will seldom subject you to capital losses if held for more than a year. SIPs in debt funds, therefore, only rarely allow you to 'average' your costs or buy units at significantly lower prices.
Of all the classes of debt funds, therefore, it is only the most volatile ones - the long- and medium-term gilt funds and income funds - where SIPs can make any sense. These two classes of funds can suffer capital losses if interest rates are on a rising cycle and thus SIPs may allow you to buy units at lower prices. For debt funds that rely mostly on accrual income (interest receipts) for returns, SIPs simply don't improve your returns.
We did an actual calculation of how SIP returns worked for the top ten performers (based on one-year returns) from different classes of debt funds for a five-year period (2011 to 2016). Expectedly, investing through SIPs gave lower returns than lump-sum investments in the case of short-term debt funds, liquid funds, ultra short-term funds and credit-opportunities funds. SIPs lifted returns by a measly five basis points for income funds.
It was only in the case of long-term and medium-term gilt funds and dynamic bond funds (which were also loaded with long-term G-secs) that SIPs made any difference at all to returns (20-30 basis points annually). To know the current equivalents of these fund categories, click here.
This column appeared in the June 2016 Issue of Mutual Fund Insight.